Name__________________________________________

ID#____________Accounting 15. 501/516Spring 2004FINAL EXAMExam Guidelines1. Fill in your name above. Exams without names will not be graded. If you donot have an ID number, leave the corresponding space blank.2. Place your name tags in front of you.3. You are free to detach any of the pages during the exam. Please make sureyou return pages 1 through 17, duly stapled, at the end of the exam.4. You are allowed to refer to a single sheet of size A4 paper that you may havebrought with you. You should not refer to sheets brought to the exam byother students. No other reference material is allowed in the exam.5. The exam has to be completed in 180 minutes. The total number of points is110. Budget your time wisely.6. Work in a clear, readable manner. Ample space is provided for everyanswer.7. Write answers in the space provided. Unreadable answers will not be graded.8. Show computations for partial credit.9. If you feel assumptions are necessary to answer a question, state allassumptions clearly.10. Laptops and computers are prohibited. You may use calculators.

Please do not fill in the following table.

Question

Total points

PART AQuestion A1

43

Question A2

PART B

25

PART CQuestion C1

19

Question C2

16Total

110

Points lost

PART A

50 points

Part A has two questions: A1 and A2. Use the financial statements of CMC Inc., acomputer manufacturer based in Texas, to answer all questions in Part A. The financialstatements are on pages 16 and 17 of this exam.Question A1

43 points

(a) What was the value of dividends, if any, paid by CMC in 2003? Showcalculations.2 points

(b) What was the value of accounts receivables declared as confirmed defaults andwritten off in 2003? Show calculations. Assume there are no recoveries whenaccounts receivables are written off.3 points

(c) 50% of total sales in 2003 were credit sales. What was the value of cash collectionon credit sales in 2003? Show calculations. Assume there are no recoveries whenaccounts receivables are written off.6 points

(d) You look for the inventory footnote and find the following information:Inventories are stated at lower of cost or market value. The last-in, first-out(LIFO) method is utilized for reporting inventories. If inventories had been valuedusing first in, first out (FIFO) method they would have been $302 and $569higher than amounts reported using LIFO at fiscal year-end 2002 and 2003respectively. During 2003, the company liquidated certain LIFO inventories thatwere carried at lower costs prevailing in prior years. The effect of this liquidationwas to increase profit before income taxes by $ 141. What Cost of Goods Soldwould CMC have reported if it had used FIFO? Show calculations.3 points

(e) Using the information in part (d), what was the difference in 2003 between Costof Goods Sold under LIFO and that under FIFO that reflected solely an effect ofchanging prices? Show calculations.4 points

(f) In 2003, CMC spent $1,500 on new investments in PP&E. CMCs totaldepreciation expense in 2003 was $777. What was the book value of assets soldin 2003? Book value of assets is defined as the difference between historical costof the asset and accumulated depreciation. Show calculations.5 points

(g) Report the complete journal entry for recording the sale of assets in 2003including the cash effect, the balance sheet effect and the income statement effect.Assume all assets sales happened in one transaction and were cash transactions.6 points

(h) Over its entire life CMC has made a single zero-coupon bond issue. This bondwas still outstanding at the end of 2003 (Net Bonds Payable of $2,985). On Jan1st, 2004, CMC retired its bond early. The market interest rate on that date was7% on these zero coupon bonds. Did CMC record a loss or a gain on retirement ofbonds on Jan 1st, 2004? Justify your answer.4 points

(i) Assume CMC had only one lease contract outstanding in 2003 and 2002, and noplans to enter another lease contract. What is the effective lease interest rate?What is the value of the annual lease payment? Show calculations. [Hint: Use theinformation provided under both Current Liabilities and Long-Term Liabilities]5+5 points

Question A2

7 points

Accruals are defined as the difference between net income after taxes (NI) and cash flowfrom operations (CFO). That is, Accruals = NI CFO. For the following questions,please refer to the Income Statement of CMC.(a) After the results for 2003 are published, the Chief Accountant at CMC discoversan error in CMCs income statement. Gain on Sale of Assets should have beenreported as $230 instead of $130, as it was actually reported. [Important: ignorethis information for Question A1]. Assume income taxes payable to thegovernment are not affected by this error. Would the correct value of accruals behigher or lower than actually reported in the financial statements of 2003? Justifyyour answer.3 points

(b) Your friend, a software programmer with no background in financial reporting

asserts Any difference in net income and CFO must be a result of accountingerrors. If companies are following GAAP, accruals should be identically zero forall companies. Would you agree with your friend? Justify your answer.4 points

Sitting Duck Inc. which operates in a similar line of business in New Hampshire. Thefollowing events took place:o Hunter acquired 10,000 shares of Sitting Duck for $10/share on Jan 1st 2002.Hunter classified this investment as AFS (Available For Sale).o On December 31st, 2002, Sitting Duck was trading for $12.40/share. Hunterdecided to hold on to its investment.o On Jan 1st, 2003, with Sitting Duck still trading at $12.40/share, Hunter acquiredanother 15,000 shares of the former.o Finally, on Jan 1st, 2004, Hunter acquired a further 41,000 shares of Sitting Duckfor $15 per share.o Hunter has never made any other equity or debt investmentTo determine percentage ownership of Sitting Duck by Hunter, use the proportion of totalSitting Duck shares acquired by Hunter. Sitting Duck had a total of 100,000 sharesoutstanding through years 2002, 2003 and 2004.. Sitting Ducks net income anddividends for 2002 and 2003 are reported below:Net incomeDividends

2002500,000100,000

2003600,000120,000

In answering the questions below, ignore deferred taxes.

(a) Report the adjusting journal entry made by Hunter on Dec 31st, 2002, to recordthe gain or loss in value of its investment in Sitting Duck.3 points

(b) Investment Income is the income that Hunter recognizes as a result of itsinvestment in Sitting Duck. What is the Investment Income reported by Hunter in2002?2 points

(c) How is Hunters investment in Sitting Duck classified in 2003? What is thebalance under Investment in Sitting Duck on Dec 31st , 2003?2+5 points

(d) Investment Income is the income that Hunter recognizes as a result of itsinvestment in Sitting Duck. What is the Investment Income recorded by Hunter in2003? Show calculations.3 points

(e) As a shareholder of Hunter, you are analyzing Hunters audited Balance sheet forYear 2004. What balance would you see under Investments in Sitting Duck atthe end of 2004? Provide reasons/calculations for your answer.2 points

goodwill of $200,000. How is goodwill defined? What does the value of goodwillrepresent in an acquisition?2+1 points

(g) What are some of the problems that arise in the implementation of recommendedprocedures for goodwill impairment testing?5 points

11

PART C

35 points

Question C1

19 points

Tyson Petrochemicals Inc. buys barrels of crude petroleum and further processes them toextract gasoline, engine oil and paraffin. A single barrel contains 50 gallons of crudepetroleum, usually referred to simply as crude. Each barrel of crude can be furtherprocessed to yield 30 gallons of gasoline, 10 gallons of engine oil and 10 gallons ofparaffin. Tyson has to incur further processing costs of $45.00 to sell the gasoline itextracts from a single barrel of crude. Similarly, Tyson incurs further processing costs of$10.00 and $2.00 before it can sell the engine oil and paraffin, respectively, that isextracted from a barrel of crude. The gasoline extracted from a barrel sells for $60.00, theengine oil sells for $15.00 and the paraffin sells for $5.00.Tyson follows a system of allocating the cost of a single barrel of crude to each of itsthree product lines by proportion of total volume by barrel. Tysons CFO thinks this is aperfectly reasonable and natural allocation scheme. Recently, prices of crude have risento $20.00 per barrel and the CFO is worried that at least one of her products will not beprofitable after the price rise.(a) What is the cost of crude allocated to each product line under the existingallocation scheme? Show calculations.6 points

12

(b) What is the net profit made by each product line after allocation of the cost ofcrude, using the current allocation scheme?3 points

(c) The CFO is extremely worried. Tyson is a price-taker in both the input and outputmarkets and yields per barrel of oil are fixed. If any of three product lines makeslosses, the CFO believes she has no choice but to discontinue selling that line. Doyou agree with her? Why/why not?4 points

(d) What is the cost of crude allocated to each product line under the correctallocation scheme that Tyson should be using? Show calculations.6 points

13

Question C2

16 points

Easy Kitchen Inc. is a large manufacturer of kitchen appliances. They have three mainproduct lines dishwashers, refrigerators and ovens. Each product line is a differentdepartment, classified as a profit center. Easy Kitchen has a department called IT SupportServices (ITSS) that is a service center for the rest of the company. ITSS providesservices on the computer information systems installed throughout the company fordesign, production, inventory control etc.. It costs $100,000 per month to run andmaintain ITSS. The three profit centers dishwashers, refrigerators and ovens - arecharged the costs of running and maintaining ITSS. The costs of ITSS are allocated to thethree profit centers based on the proportion in which their sales revenues contribute tototal revenues. The product lines are viewed as sufficiently profitable, but recently, someproduct line managers have complained about the allocated charges for ITSS. Here issome data on monthly figures for each profit center.Sales revenueNumberofexclusiveconferences between ITSSpersonnel and profit centerengineersAverage length of conference(in hours)Conference-hours

Dishwashers$250,00013

Refrigerators$450,00025

Ovens$100,0007

52

75

35

Total800,00045

162

The total number of hours per month spent by ITSS personnel in exclusive conferenceswith the engineers of each profit center is referred to as conference-hours. A consultantrecommends that Easy Kitchen should shift to an activity-based costing (ABC) systemusing conference hours as the cost driver to allocate ITSS costs to the three profit centers.This system has not been implemented yet.(a) What is the allocation of ITSS costs based on the current system?5 points

14

(b) Assume the consultant was successful in identifying the true cost-driver of ITSScosts. If profit center heads also realize what the true cost drivers are, which oneis likely to be the most dissatisfied with the current system of allocating costs?Why? Show calculations to support your answer.6 points

(c) Recall the death spiral problem we discussed in Seligram. Describe how EasyKitchen could potentially head for a death spiral if the current allocation system isnot abandoned. A detailed numerical answer is not necessary, but your argumentsshould be clear and concise.5 points

Total Liabilities & Stockholders Equity

8,257

9,472

LIABILITIES & STOCKHOLERS EQUITY

Current LiabilitiesAccounts PayablePresent Value of Lease Obligation current portionsOther current liabilitiesTotal current liabilitiesLong Term LiabilitiesNet Bonds PayablePresent Value of Lease Obligation non-currentportionsTotal long term liabilities

17

Income Statement of CMC Inc.

During the yearRevenuesCost of Goods SoldGross profits

20037,000(4,550)2,450

Selling, General and Administrative Expenses

Bad Debt ExpenseTotal interest and rental expenses*Operating profits

(803)(75)(472)1,100

Gain on Sale of Assets

Profit Before TaxesTax expenseNet Income

1301,230(369)861

* This includes interest on bonds payable, lease interest and some other miscellaneousinterest and rental payments that are not zero.